Lithuania’s economic development and outlook
The second lockdown failed to knock Lithuania’s economy off its growth path. GDP growth recorded in both the first and the second quarters shows that Lithuania’s undertakings managed to make adequate preparations for the new wave of the pandemic. Lithuania’s exporters continued to increase their sales volumes in external markets, benefitting from the recovery of demand in main trade partners in the process of their reopening. Even though the biggest boost to the growth of exports came from chemical and furniture industries, many other manufacturing industries also contributed to higher export volumes. Many of these industries reached the highest output level in the history of the data series in the second quarter of this year. Successful expansion in external markets, robust financial health of the country’s undertakings and new highs in terms of industrial capacity utilisation had a positive effect on business expectations, which in turn fuelled the recovery of the private sector’s investment. A fall in external demand following the onset of the pandemic and uncertainty over the global economic outlook triggered a slump in investment. Even though investment entered the recovery mode in the second half of 2020, it was then mostly driven by the public sector, while the private sector waited until the beginning of this year to start stepping up its investment. Favourable dynamics in the tradable sector facilitated the continuation of labour market developments favouring workers. This coupled with the reopening of other activities and general government decisions led to improvements in household disposable income as well as in household expectations. All these factors contributed to an increase in household consumption, which followed an upward trend in both the first and the second quarters of this year. However, an increase in household consumption expenditure was rather moderate in the second quarter of this year, even though the government eased the lockdown restrictions substantially and household disposable income continued to far exceed the expenditure. At the same time, according to the Bank of Lithuania, the country’s households maintained their saving rate at a historically high level.
Economic growth leads to improvements in the labour market. Employment has been growing in the country since the beginning of this year, reversing the slump suffered in 2020. On top of that, the number of people at work got back to the pre-pandemic level in the middle of the year. However, job creation has varied significantly across economic activities. Employment in the activities less affected by the pandemic, such as information and communications, transport and warehousing or manufacturing, set on an upward path in early 2021. Meanwhile, it took until the second quarter of this year for employment in more affected activities, such as accommodation and catering services, to enter recovery, after the beginning of a gradual easing of lockdown restrictions imposed on those sectors. The pickup of hiring has increasingly brought to light the problem of labour shortage, which was evident even before the pandemic and has also been one of the main causes behind particularly rapid wage growth. Even though the average wage in the country has been already growing at a rather rapid pace before the pandemic, its growth picked up further after the first lockdown and, starting from the third quarter of 2020, salaries recorded double-digit growth on average in both the private and the public sectors. Such average wage dynamics were driven considerably by the government’s decisions to raise salaries in the public sector and for the lowest-income earners. Wage growth was also likely supported by the disbursement of jobseekers’ allowances, which possibly acted as a disincentive to search for work. The room for such rapid wage growth was also provided by the decisions made during the pandemic to bolster operational efficiency and to adapt to the pandemic conditions, which enabled Lithuania’s businesses to achieve significant productivity gains. In fact, the pace of productivity growth in Lithuania was among the fastest across the EU in 2020.
Further growth of Lithuania’s economy will continue to depend on the global handling of the pandemic situation, the increasing recovery of domestic demand and the development of export-oriented activities. The scale of the pandemic and the adjustment thereto will continue to have a decisive impact on economic activity, both in Lithuania and abroad. It is assumed that Lithuania will continue vaccinating its population successfully in the coming months, which, alongside other measures, will reduce the incidence of COVID-19 and, accordingly, will make it possible to avoid restrictions on everyday life and businesses, which could significantly affect economic activity. This will open up more opportunities for households to purchase the desired goods and services. Their appetite for consumption has been growing recently, which can be seen from the share of households considering major purchases that has hit the highest level since the beginning of the global crisis. The return to more normal consumption habits and the decline of excess savings should emerge as one of the key factors driving the rapid growth of household consumption, which should outpace even the increased growth of disposable income in the years to come. The expected economic recovery in advanced countries, which comprise a significant share of Lithuania’s major trade partners, will fuel demand for Lithuanian-origin goods and, accordingly, will benefit the country’s exporters. External demand for the goods of Lithuanian origin is currently expected to exceed its year-earlier level by more than 8% this year, but its pace of growth would halve in subsequent years. Demand is expected to increase in both domestic and external markets, boosting business expectations. This will continue to fuel the private sector’s investment, which will also be driven by the intensified inflows of EU support funds. All these factors are expected to translate into rather substantial economic growth in the coming years, with Lithuania’s real GDP projected to increase by 4.9% in 2021 and by another 3.5% in 2022.
The rapid recovery of the Lithuanian and global economy has been accompanied by rising inflation. Inflation has been pushed up mainly by the rising prices for crude oil, their low comparison base and higher prices for other commodities, such as metals. Longer than expected supply disruptions and tensions in the global commodity market have contributed to a pickup in the growth of prices for industrial goods. An increase in the supply of commodities should bring the demand and supply of many commodities back into balance, which should be similar to their pre pandemic equilibrium in the future, whereas the reduced level of inventories should be restored, which makes it likely that prices for many commodities will tend to go downwards in the future. However, prices for industrial goods are expected to continue their rapid growth both in the remaining months of this year and early next year. Higher global prices for food commodities, a poor vegetable harvest and higher other costs, including higher wages, will trigger a pick-up in the rate of food inflation. Nonetheless, food inflation will be lower on average than before the pandemic in both 2021 and 2022. The expected rapid wage growth, which will be mostly driven by the labour shortage, convergence and built-up savings that will be increasingly channelled to the services sector, will also have repercussions for the services inflation, which will go up. Inflation is expected to reach 3.3% in Lithuania this year, exceeding the previous forecast by around 1.1 percentage points. Year-on-year, the inflation rate will increase by 2.2 percentage points, mostly due to rising prices for energy products and industrial goods. Next year, inflation will go down to 2.2% due to a lower upward pressure from energy prices. At the same time, it will come under a stronger impact from services prices that are more closely linked to domestic economic developments. Inflation may also be pushed up next year by stronger food inflation.
Outlook for Lithuania's economy
|
September 2021 projectiona |
June 2021 projection |
|||||
|
2020 |
2021b |
2022b |
2020 |
2021b |
2022b |
|
|
Price and cost developments (annual percentage change) |
||||||
|
Average annual HICP inflation |
1.1 |
3.3 |
2.6 |
1.1 |
2.2 |
2.1 |
|
GDP deflatorc |
1.1 |
3.9 |
2.5 |
1.1 |
2.0 |
2.0 |
|
Wages |
10.2 |
9.4 |
7.6 |
10.2 |
7.0 |
5.9 |
|
Import deflatorc |
–5.2 |
4.3 |
1.8 |
–5.2 |
3.9 |
1.5 |
|
Export deflatorc |
–3.5 |
2.9 |
2.1 |
–3.5 |
2.8 |
1.3 |
|
Economic activity (constant prices; annual percentage change) |
||||||
|
Gross domestic productc |
–0.8 |
4.9 |
3.5 |
–0.8 |
5.1 |
4.1 |
|
Private consumption expenditurec |
–2.1 |
5.6 |
6.6 |
–2.1 |
6.2 |
6.5 |
|
General government consumption expenditurec |
0.5 |
0.1 |
0.0 |
0.5 |
0.3 |
0.0 |
|
Gross fixed capital formationc |
0.1 |
11.1 |
6.3 |
0.1 |
8.5 |
5.5 |
|
Exports of goods and servicesc |
0.0 |
11.4 |
4.6 |
0.0 |
8.2 |
5.9 |
|
Imports of goods and servicesc |
–5.7 |
14.8 |
7.4 |
–5.7 |
11.4 |
7.9 |
|
Labour market |
||||||
|
Unemployment rate (annual average as a percentage of labour force) |
8.6 |
7.2 |
6.8 |
8.5 |
7.1 |
6.6 |
|
Employment (annual percentage change)d |
–1.7 |
0.6 |
0.2 |
–1.5 |
0.7 |
0.4 |
|
External sector (percentage of GDP) |
||||||
|
Balance of goods and services |
10.0 |
7.4 |
5.8 |
10.0 |
7.7 |
6.3 |
|
Current account balance |
8.3 |
5.4 |
3.6 |
8.4 |
5.6 |
3.6 |
|
Current and capital account balance |
10.4 |
8.0 |
6.3 |
10.4 |
8.2 |
6.3 |
aThe projections of macroeconomic indicators are based on international environment assumptions based on information published by 18 August 2021 as well as other data and information made available before 31 August 2021
b Projection.
c Adjusted for seasonal and workday effects.
d National accounts data; employment in domestic concept
1.International environment
The pace of post-pandemic recovery has been uneven across countries.
Chart 1. Implications of the pandemic on GDP outlook
(index: 2019 = 100)
Source: IMF.
The European Union countries have been recovering from the pandemic at an uneven pace.
Chart 2. Projected GDP level in selected countries compared to Q4 2019
Source: EC.
The neighbouring countries have been heading firmly towards recovery from the pandemic shock. The economies of Poland and Latvia expanded by 10.9% and 10.3%, respectively, in the second quarter of this year, compared to the same period last year. Economic growth was mainly driven by inter alia the easing of lockdown restrictions, which used to weigh heavily on activity in the services sector of those countries. Jobless rates in the neighbouring countries moved down in the second quarter of this year, yet unemployment in Latvia and Estonia still exceeded its pre-pandemic levels in July. Unemployment rates reached 5.9% in Poland, 7.4% in Latvia, and 7.7% in Estonia. Moreover, the European Commission expects the GDP of Poland, Latvia and Estonia to grow by 4.8%, 3.8% and 4.9%, respectively, this year, and sees the economies of these countries getting back to their pre-pandemic levels by the end of this year (see Chart 2). The main risk for the economic outlook of the neighbouring countries continues to arise from new COVID-19 variants and related outbreaks both inside these countries and in their trade partners.
2.Monetary policy of the Eurosystem
Over the past six months, the ECB Governing Council has further strengthened its accommodative monetary policy stance. The high level of the accommodative monetary policy is ensured by low ECB key policy rates, asset purchase programmes, long-term lending operations as well as forward guidance. At its March and June meetings, the Governing Council decided that asset purchases under the pandemic emergency purchase programme (PEPP) over the second and the third quarters of this year should be conducted at a significantly higher pace than during the first months of the year. Such decisions were adopted in order to maintain favourable financing conditions for all sectors of the economy and help counter the negative impact of the pandemic-triggered crisis on the path of inflation in the euro area. At its September meeting, the Governing Council decided that, in view of slight improvements in financing conditions and the inflation outlook, asset purchases under the PEPP over the fourth quarter of this year would be conducted at a moderately lower pace than in the previous two quarters.
In July, the Governing Council approved its new monetary policy strategy and, in this context, revised its forward guidance on interest rates. According to the new strategy, price stability is best maintained by aiming for a 2% inflation target over the medium term (for more details on the outcome of the monetary policy strategy review, see Box 1). In view of this inflation target and the existing circumstances, the Governing Council also revised its forward guidance on interest rates by establishing that the key ECB interest rates would remain at their present or lower levels until the Governing Council saw: 1) inflation reaching 2% well ahead of the end of its projection horizon and durably for the rest of the projection horizon, and judged that 2) realised progress in underlying inflation was sufficiently advanced to be consistent with inflation stabilising at 2% over the medium term. This might imply a transitory period in which inflation would be moderately above the target.
Even though inflation has increased strongly in the euro area over recent months, this spike has been seen as largely driven by temporary factors, hence market analysts do not expect interest rates to rise in the near future. The index measuring changes in the prices of a basket of goods and services in the euro area saw its annual pace of growth accelerate to 3% in August 2021, from –0.3% in December 2020 (see Chart 3), but this increase is expected to be temporary. Recently, inflation has been mostly driven by strong base effects stemming from a slump in oil prices, which occurred early in the pandemic and has already reversed, bringing the prices of oil back to their pre-pandemic level, and the reversal of the temporary German VAT rate cut in January 2021. Temporary disruptions in the supply of inputs and certain other goods as well as the recovery of demand for some services have added to the upward pressure on inflation. These factors are nonetheless expected to fade from the beginning of next year, bringing down inflation, which should be below the adopted target of 2% over the medium term. Hence market analysts continue to expect the ECB to maintain its accommodative monetary policy stance and the short-term interest rates set by the ECB to remain at their present or lower levels for at least a couple more years.
ECB interest rates have remained exceptionally low.
Chart 3. Actual ECB interest rates, euro area inflation and market expectations
Sources: ECB and Refinitiv.
Note: Data as of 10 September.
Financing conditions have remained favourable.
Chart 4. Average interest rates on new MFI housing loans and loans to NFCs
Sources: ECB and Bank of Lithuania calculations.
Note: 3-month moving average.
On 8 July 2021, the Governing Council of the ECB published the results of the Eurosystem’s monetary policy strategy review. The main results of the strategy review include the following elements:
·adoption of a symmetric inflation target of 2% over the medium term;
·confirmation that HICP remains an appropriate price measure and a recommendation to include the costs related to owner-occupied housing in this index over time;
·approval of an ambitious climate change action plan.
Price stability will be maintained by deploying both conventional and unconventional measures while aiming for the inflation rate of 2% over the medium term. The new definition is clearer compared to the previous formulation of “below, but close to, 2%”. This new target is symmetric, meaning negative and positive deviations of inflation from the target are equally undesirable. As previously, the set of ECB interest rates will remain the primary monetary policy instrument. However, when the economy comes close to the effective lower bound on nominal interest rates, it requires forceful or persistent monetary policy action to avoid negative deviations from the inflation target becoming entrenched. For this reason, unconventional instruments, such as forward guidance, asset purchases and longer-term refinancing operations, will also continue to be used as appropriate. As admitted during the strategy review, active use of various instruments may give rise to transitory periods, in which inflation will be moderately above target. Hence, 2% is not a ceiling, as was often the case with the interpretation of the previous formulation of the price stability objective.
It was decided during the strategy review to continue following the principle of medium-term orientation in pursuit of the inflation target. The medium-term orientation provides flexibility, given the time lags in the effects of monetary policy on the economy and inflation. This flexibility also allows to take account of other considerations relevant to the pursuit of price stability, such as the situation in the labour market, when adopting monetary policy decisions.
The ECB Governing Council acknowledged the profound implications of climate change for price stability and, accordingly, committed to an ambitious climate change-related action plan. While governments and parliaments have the primary responsibility to act on climate change, within its mandate, the ECB also recognises the need to further incorporate climate considerations into its policy framework. The action plan contains the following commitments:
·to further incorporate climate change considerations into the monetary policy framework of the Eurosystem;
·to expand the analytical capacity in macroeconomic modelling, statistics and monetary policy with regard to climate change;
·to include climate change considerations in monetary policy operations in the areas of disclosure, risk assessment, collateral framework and corporate sector asset purchases;
·to implement the action plan in line with progress on the EU policies and initiatives in the field of environmental sustainability disclosure and reporting.
It was decided to review the monetary policy strategy on a regular basis in the future. Yet another important outcome of the strategy review was the commitment of the Governing Council to assess periodically the appropriateness of its monetary policy strategy, with the next assessment expected in 2025.
The first regular monetary policy meeting of the Governing Council applying the new strategy was held on 22 July 2021. During that meeting, the Governing Council revised its forward guidance on interest rates to reflect the new inflation target.
3.Real sector
Both compensation of employees and operating surplus as well as mixed income followed an upward path in the first half of 2021.
Chart 5. Contributions to nominal GDP measured by the income approach
Sources: Statistics Lithuania and Bank of Lithuania calculations.
The growth of disposable income, the easing of pandemic restrictions and improvements in expectations fuelled household consumption, which increased by 6.7% year on year in the first half of this year (see Chart 6). However, such a pace of growth in household consumption should nonetheless be considered as limited, given that households were unable to implement some of their spending decisions (for instance, travel or some other entertainment) due to the restrictions in force. The country’s households continue to hold sizeable financial resources built up by saving, which is reflected in both the volumes of deposits accumulated at MFIs and in the saving rate, which, as estimated by the Bank of Lithuania, remains at historic highs, and shows that the income of the country’s households continues to far exceed their expenditure. However, the share of households considering major purchases has hit the highest level since the beginning of the global financial crisis, which signals the willingness of households to step up consumption. The return to more normal consumption habits and tendencies should act as one of the key factors driving the rapid growth of household consumption, which in the years to come should outpace even the elevated growth of disposable income that would result from the rapid wage growth as well as the growth of household property and entrepreneurial income as well as social welfare benefits. Should the country avoid the third strict lockdown, a decline in excess saving and the rapid growth of disposable income should offset the impact of temporary elevated inflation, which limits the growth of purchasing power. Household consumption is projected to increase by 5.6% this year and by 6.6% next year.
Even though the growth of disposable income, the easing of restrictions and improvements in expectations provided the impetus for household consumption, its growth remained limited.
Chart 6. Contributions to real GDP measured by the expenditure approach
Sources: Statistics Lithuania and Bank of Lithuania calculations.
Investment has been growing at a rapid pace, driven by the recovery of private sector investment. A fall in external demand following the onset of the pandemic and uncertainty over the global economic outlook triggered a slump in investment, which, however, went into the recovery mode as early as in the second half of 2020. Investment was initially mostly driven by the public sector while the private sector waited until the beginning of this year to start stepping up its investment. As a result, investment rose by 15.1% year on year in the first half of this year, with increases recorded in almost all investment categories (see Chart 7). Between January and June, private sector investment was mostly driven by the recovery of external demand, improvements in business expectations, robust financial wellbeing of the country’s businesses and the production capacity utilisation rate that approached record highs in that period. These factors acted as the main driving forces of the growth of investment in capital goods. However, the short-term development of this type of investment is likely to be limited due to a slowdown in the construction of production facilities, which was observed last year and only went into reverse this year and which also led to delays in the installation of capital goods in those premises. Looking at all investment categories in general, the recovery of investment in non-residential buildings and structures have been the most subdued thus far due to not just the private sector’s decisions (for instance, those related to uncertainty over the outlook of demand in hotel or office services), but also because of general government investment, which contributes significantly to investment in engineering works, but is not expected to increase substantially this year. On the other hand, the situation observed in another segment of the construction industry – investment in housing development – has been the opposite. This type of investment rose by 6.1% year on year in the first half of this year, which was mostly due to the growing financial capacity of the country’s households, which gives rise to demand for developers in this segment. The numbers of building permits issued and the volume of construction starts point to the expected further growth of this type of investment. The first half of the year also saw a particularly rapid growth of investment in vehicles. Even though the annual growth rate depends to a considerable degree on the base effect, the data indicates that the transport sector has been scaling up investment despite a range of challenges (such as the Mobility Package, the reduction of labour quotas or geopolitical tensions). Investment in information and communication technology (ICT) equipment demonstrated the most rapid growth last year, driven by the huge and sudden demand for digitalisation triggered by the COVID-19 pandemic in 2020, and has continued to increase at a rapid pace this year. Moreover, the level of this investment should remain high in the future, as both Lithuania and the entire world become increasingly focused on the digitalisation solutions. Investment is projected to increase by 11.1% this year and by another 6.3% next year.
In the first half of the year, investment was driven by the recovery of external demand, improvements in business expectations, robust financial wellbeing of the country’s businesses and the capacity utilisation rate that approached record highs.
Chart 7. Contributions to investment
Sources: Statistics Lithuania and Bank of Lithuania calculations.
4.Labour market
The recovery of economic activity in Lithuania and foreign countries has led to improvements in the labour market. During the pandemic, the labour market faced the most extreme conditions in the first year of the crisis. In 2020, when the future was surrounded by uncertainty about the evolution of the epidemiological situation, the increase in downtime and the unemployment rate was observed, while the number of employees has decreased. Labour market indicators moved onto the positive path, once it became increasingly evident that many businesses could continue their economic activity uninterrupted even despite the high incidence of COVID-19 and the repeated emergence of new hotspots. The viability of businesses was also underpinned by the increased prevalence of remote work and better preparedness of the country’s undertakings to detect and respond to potential clusters of COVID-19 cases among their employees. All these factors and the recovery of demand as well as the continued implementation of stimulus measures had a beneficial effect on the development of companies and on the hiring of employees. The number of employees in the country started growing in early 2021 and got back to the pre-pandemic level in the middle of the year (see Chart 8). At the same time, hiring developments varied greatly across economic activities. In the first half of 2021, a particularly large increase in the number of employees was recorded in information and communications, transport and warehousing as well as manufacturing sectors. Meanwhile, employment in the accommodation and catering services sector, which suffered the biggest fallout from the pandemic, continued to decrease in early 2021 and only moved into the recovery mode in the middle of the second quarter following the easing of restrictions applied to the supply of these services.
The number of employees started growing in early 2021 and got back to the pre-pandemic level in the middle of the year.
Chart 8. The number of employees in the private sector
Sources: Sodra and Bank of Lithuania calculations.
During the pandemic, Lithuania’s businesses stood out among their European peers in terms of rather robust growth in labour productivity. Last year, the fall in demand and the ensuing necessity to cut costs led to a decline in the total number of hours worked by employees in Lithuania, which decreased by 5.9%. The downward trend in hours worked prevailed in many EU countries: the number of hours worked across the EU fell by 6.6%. However, both Lithuania and other EU countries sought to boost the efficiency of using labour resources in difficult times. In other words, employers looked for opportunities to enhance productivity in a bid to offset, at least partially, the negative shock of the pandemic. As a result, the added value per hour worked increased by 5.4% in Lithuania in 2020. Labour productivity growth in Lithuania was among the fastest across the EU and its rate was approximately ten times as fast as in the whole of the bloc (see Chart 9). Such labour productivity developments in Lithuania were also likely driven by the solid growth of investment prior to the pandemic, in particular, the investment more conducive to operational efficiency. For instance, in the period of 2017 to 2019, investment in information and communication equipment increased by approximately 18% on average per year, while investment in intellectual property products grew by around 11% on average. The above-mentioned investment continued to grow considerably in 2020 – the year that brought the need for immediate solutions allowing to improve productivity and adapt to the pandemic environment.
The growth rate of labour productivity in Lithuania was among the fastest across the EU in 2020.
Chart 9. Labour productivity in the EU countries in 2020
Sources: Eurostat and Bank of Lithuania calculations.
Note: based on the hours worked data.
The pickup of economic activity has increasingly brought to light the problem of labour shortage, which, in turn, has put upward pressure on wages. The lack of labour was evident even before the pandemic crisis and was one of the main causes behind substantial wage growth. Wage pressures diminished briefly at the onset of the pandemic amid high uncertainty over the economic outlook and the decreasing demand for workers, which even led to a decline in average wages in the private sector in the second quarter of 2020, compared to the previous quarter. The rebound of economic activity brought back to light the long-standing problems in the labour market, in particular, the problem of labour shortage exacerbated by the deterioration in the domestic demographic situation amid broadly balanced international migration of the country’s population, which contributed to wage growth even during the period of re-tightened restrictions on movement and business activity, i.e. in late 2020 and in early 2021. As a result, wages continued their upward trend in many economic activities during that period (see Chart 10), which, however, was not the case with the accommodation and catering sector that was hardest hit by the pandemic and recorded a somewhat larger decline in wages at that time. Throughout the pandemic period, the growth of average wage in the country was driven substantially by the government’s decisions to raise salaries in the public sector. Wages of healthcare workers logged a particularly steep rise in 2020 and 2021, which was partly due to the nature of the crisis. Wage dynamics were also likely affected by other general government decisions, namely the disbursement of jobseekers’ allowances, which possibly acted as a disincentive to seek work.
Average wage showed solid gains in late 2020 and in early 2021, despite re-tightened restrictions on movement and business activity.
Chart 10. Wages in selected economic activities
Sources: Statistics Lithuania and Bank of Lithuania calculations.
Note: seasonally adjusted data.
5.External sector
Lithuania’s export and import volumes followed an upward trend in the first half of 2021. National accounts show that real exports of goods and services increased by 3.9% between January and June, compared to the previous six-month period, while imports grew by 6.6%. The recovery of external demand and the adaptation of Lithuania’s businesses to the pandemic environment fuelled further growth in export volumes, whereas improvements in expectations about the future coupled with increasing household income and the ensuing growth in consumption acted as a driver of imports. The contribution of merchandise trade to the growth of exports in the first half of 2021 was more than twice as strong compared to the effect of trade in services. The difference between the effect of merchandise and services imports was even more pronounced. The growth of exports continued to be mostly driven by chemical products and plastics as well as wood and the articles of wood. The former category of goods also contributed to the rapid growth of imports, contrary to the latter category. With demand in external and domestic markets following an upward trajectory, Lithuania’s exports and imports are expected to rise, yet imports are seen expanding at a faster pace due to the expected stronger demand for commodities and equipment underpinned by the development of production as well as due to the recovery of household consumption. The main sources of risk to the expected foreign trade developments include the further course of the pandemic, disruptions in global commodity supply chains and geopolitical factors.
Foreign trade volume has been growing, supported by increasing external and domestic demand, yet merchandise and services trade has been recovering at varying paces.
Chart 11. Dynamics of Lithuania’s foreign trade and external demand
(at constant prices, seasonally adjusted data)
Sources: Statistics Lithuania, Bank of Lithuania and Bank of Lithuania calculations.
Chemical and wood industries have provided the biggest boost to the growth of merchandise exports.
Chart 12. Growth factors of real and seasonally adjusted merchandise exports
(change from the previous period)
Sources: Statistics Lithuania and Bank of Lithuania calculations.
With global foreign trade recovering, the growth in market shares of Lithuania’s merchandise exports has lost momentum. The pace of growth in the global market share of Lithuania’s merchandise exports slowed down in the first quarter of 2021 on a year-on-year basis, getting back to its long-term trend. In 2020, the exceptionally rapid growth in Lithuania’s market shares resulted from the pandemic-driven factors. During the pandemic, Lithuania’s chemical industry launched the production of reagents and other products required to contain the spread of the virus and was able to boost its exports rapidly on the back of elevated demand. The country’s wood industry recovered sharply from the initial shock, given that it never stopped working during the pandemic and invested in production capacity. The culture of work from home opened up by the pandemic and built-up savings, which were partly channelled into home renovation, led to an increase in demand for wood products and furniture in the period under review, which propelled the sales of Lithuania’s wood products in external markets. Nearly all EU countries have recorded increases in foreign trade volumes in 2021 amid the recovery of the global economy, which have been driving supply in the international markets towards its pre-pandemic level. The growth in the market share of Lithuania’s foreign trade should remain unchanged in the short term, but its evolution might be affected by the capacity utilisation rate, which has reached historic highs. A shortage of production capacity, which may arise due to a lack of dedicated investment in the medium term, may restrain the development of production and exports.
Merchandise exports have been recovering in most EU countries.
Chart 13. Development of merchandise exports of the Baltic and EU countries
Sources: Eurostat and Bank of Lithuania calculations.
Note: EU27 means the interval between the minimum and the maximum value in EU countries.
With uncertainty over the pandemic becoming less pronounced, businesses have been investing and rebuilding their inventories. Lithuania’s imports experienced a much steeper fall than exports early in the pandemic, but their ensuing growth underpinned by the commensurate recovery of domestic demand has also been more rapid. The volume of imports, as measured at constant prices, exceeded its 2019 level as early as in the second half of 2020. It has continued its upward trend in 2021, supported in particular by intermediate consumption goods, which are used in production and represent the bulk of the country’s merchandise imports. A significant impetus for the growth of imports has also been provided by investment goods. However, the growth of imports has mostly been driven by the category of merchandise including motor vehicles, trailers and semi-trailers. Parts of products falling into this category are re-exported, but the majority of these goods represent investment made by transport and other sectors. Growth in the imports of intermediate consumption goods has been linked with the rebuilding of inventories fuelled by positive expectations about the future outlook, but it has also likely been driven by elevated demand due to the shortage of commodities in the market.
The recovery of services trade has been more subdued, and the volume of their imports and exports, as measured at constant prices, has remained below the level of 2019. In 2021, imports and exports of services have still remained below their pre-pandemic levels, but the volume of foreign trade in services has also been recovering gradually. The recovery of exports has been driven by the growing exports of information and communication as well as other business services. The development of Lithuania’s transport services has been marred by uncertainty in 2021 in particular as the restrictions on trade with Belarus and the suspension of fertilizer re-exports in the second half of the year may have negative repercussions for the sector’s performance. Improvements in the pandemic situation have led to the recovery in the exports of travel services amid the resumption of trips to many destinations and the increasing tendency among people to choose a vacation abroad. The recovery of services imports has mostly been fuelled by the growing volume of transport services.
The projected return of foreign trade development to normalcy may be hindered by certain unfavourable factors. The recovery of the external sector has been broad-based, but its growth has been uneven. The Bank of Lithuania expects the country’s exports to increase by 11.4% in 2021 and its imports to rise by 4.6%. Even though the evolution of the pandemic is still hardly predictable, the economies of Lithuania’s main trade partners have been recovering, leading to stronger demand in 2021, which should get back to normal in 2022. Potential downside risks lurking in 2021 include the effect of supply chain disruptions, a stronger than expected impact of restrictions on trade with Belarus and a potential deterioration in trade conditions with China.
6.Prices
Annual inflation has accelerated significantly in Lithuania since March 2021 and has stood at 4.6% on average over the past couple of months. Higher inflation reflects the rapid recovery of both Lithuanian and global economies as well as the increased prices of commodities and certain components affected by supply and demand imbalances. Inflation has been pushed up mainly by the rising prices for crude oil, their low comparison base, and higher prices for other commodities, such as metals. These factors have contributed to a pickup in the growth of prices for fuels and industrial goods as well as administered prices (see Chart 14). Even though the existing supply disruptions, leading to higher prices of commodities as well as increased costs and longer times of their delivery, and the base effect are seen as temporary, the annual inflation rate is nonetheless expected to remain elevated both late this year and early next year. The average annual inflation is projected to reach 3.3% this year before slowing down to 2.6% next year.
The acceleration of inflation in Lithuania has been driven mostly by external factors.
Chart 14. HICP inflation and its contributions
Sources: Statistics Lithuania and Bank of Lithuania calculations.
Early in 2021, energy prices still continued to put downward pressure on the consumer price index but have since turned into the main driver of inflation. In July and August, fuel prices in Lithuania exceeded their year-earlier levels by approximately one-fifth, driven by the recovery of oil prices from their early pandemic slump and the base effect. Even though annual fuel inflation indeed appears significant, it is however important to note that the prices of the most popular types of fuel (diesel fuel B7, gasoline A-95) in July were close to their levels recorded in the respective month of 2019. Oil prices are not expected to go much higher, given the crude output hikes implemented by OPEC+ from August and in view of the downward risk to oil demand posed by the rapid spread of the Delta variant. In addition to higher fuel prices, energy inflation has also been driven substantially by the developments in the prices of electricity and natural gas. With electricity and natural gas exchange prices tracking an upward trend, prices charged to household users followed suit in July and, as a result, electricity prices rose by 7.8% on average that month, whereas prices of natural gas and cooking gas soared by 38.6% on average.
The rise in commodity prices has contributed to a pickup in the growth of prices for industrial goods.
Chart 15. Effect of industrial goods prices on annual inflation
Sources: Statistics Lithuania and Bank of Lithuania calculations.
Annual growth in food prices has accelerated in recent months. In early 2021, food prices stood below their year-earlier levels on average, but later annual food inflation gathered steam to reach 3.2% in August, which was largely due to the lower production of vegetables harvested in Lithuania this year that led to a pickup in vegetables inflation. In August, prices for vegetables rose by more than one-tenth year on year, contributing 0.3 percentage point to headline inflation. Food prices in Lithuania have also been affected by recent rises in global prices for food commodities. Global food prices declined somewhat from the peak reached in May but nonetheless exceeded their year-earlier level by nearly one-third in August. In the remaining months of 2021, food inflation will continue to be substantially driven by higher global prices for food commodities as well as higher than a year ago purchase prices for certain agricultural products in Lithuania.
The annual pace of growth in services prices has remained subdued, compared to the pre-pandemic period (they reached 3.5% in August). However, the growth trends in the prices of services rendered by many sectors hit hard by the pandemic have been getting back to their pre-pandemic levels. With the base effect wearing off, the annual pace of growth in the prices for dental services decelerated to mere 4.9% in August, from more than 14% in April and May, while the annual medical services inflation slowed down to 6.6% from more than 10%. The recovery of demand and the rise in oil prices have reversed a decline in the prices for flight services, which rose by approximately 9% in August year on year. Moreover, the prices for services provided by catering, sport and cultural sectors have followed an upward path, even though the VAT rate applied to the sectors was cut to 9% from 21% in July. For instance, the prices of catering services increased by 1.4%, while the prices of movie, theatre and concert tickets picked up by as much as 4% in July, while in August they were higher by 5.6% and 7.7% respectively than a year ago. Given that wage costs make up a large portion of services costs, the relatively rapid wage growth will put upward pressure on services prices. Services inflation is expected to accelerate late in 2021 and is seen reaching 3.5% on average this year. Next year, it should rise to 3.8%, but will nonetheless be lower than in 2020.
Increases in the prices of a wide range of raw materials used in industrial production, construction and food production as well as in housing prices have been observed in recent months. How does that affect the dynamics of the general level of consumer prices, i.e. inflation?
Chart A. Prices of aluminium, copper and steel rebar
Source: London Metal Exchange.
Chart B. Changes in producer prices and in the prices of non-energy industrial goods
Sources: Statistics Lithuania and Bank of Lithuania calculations.
Chart C. Changes in the prices of construction inputs – materials and products
Source: Statistics Lithuania.
Hence, the rising prices of commodities and housing do have a more substantial effect on individual sectors, but only an indirect effect on inflation measuring the expenditure of an average consumer. Commodity prices affect inflation only indirectly – to the extent their increases are passed through to the consumer prices of goods and services. Housing prices are currently excluded from inflation calculations, but the new monetary policy strategy envisages the consistent inclusion of consumption expenditure related to owner-occupied housing in the inflation index in the future.
7.Financing of the economy
With the flows of lending for house purchase, consumption and other purposes following an upward trend, the portfolio of loans granted by MFIs to households moved along the same path in the second quarter of 2021. The flow of new loans granted by MFIs to households in the second quarter of 2021 increased by 25.5%, compared to the previous quarter, and exceeded the average quarterly flow recorded in 2019 by 54.5% (see Chart 16). This growth in the flow of loans was mostly driven by housing loans, as their flow grew by one-fifth (19.7%) during the second quarter supported by strong activity in the housing market. The flow of new loans for consumption and other purposes soared by 49% in the second quarter from the previous quarter, and its growth was fuelled by improvements in the labour market and the easing of lockdown restrictions over recent months. The growth in the flow of loans to households led to the widening of the MFI household loan portfolio, which achieved an annual growth pace of 8.6% in July 2021 (up by 1.6 percentage points, compared to the growth rate recorded in April) (see Chart 17). The growth of the portfolio was mostly driven by housing loans, which saw the annual growth pace of their portfolio hit 10.9% (up by 1.4 percentage points from April). With the flows of loans for consumption and other purposes following an upward trend, the annual pace of contraction in this loan portfolio decelerated to 1.6% in July, from 4.1% in April.
MFI lending to NFCs and households has been gathering pace.
Chart 16. Flows of MFI loans to NFCs and households
Source: Bank of Lithuania.
The flows of MFI lending to Lithuania’s NFCs demonstrated a growth trend in the second quarter of 2021, which led to a deceleration in the annual pace of contraction in the portfolio of loans granted to these corporations. The flow of MFI lending to NFCs gathered pace in the second quarter of 2021 and increased by 10%, compared to the first quarter, or by 22.9%, compared to the average quarterly flow recorded in 2019. Quarter-on-quarter, the flows of lending to businesses engaged in manufacturing, construction and real estate operations registered the highest quarterly growth rates. With lending flows increasing, the portfolios of loans granted to separate economic activities stopped shrinking or contracted at a slower pace in most cases as well. The overall portfolio of loans granted by MFIs to NFCs shrank year on year by 0.3% in July 2021 (yet its annual pace of contraction decreased by 8.4 percentage points, compared to April), but increased by 2.7% from April and hit the highest level since October 2020. The annual decrease in the overall portfolio was mostly due to the continued contraction in the portfolios of loans granted to trade as well as professional, scientific and technical activities. Meanwhile, the portfolio of loans granted to real estate operations followed the path of growth.
Growth in the MFI household loan portfolio has gathered steam thanks to the rapid pace of lending for house purchase, whereas the contraction of the corporate loan portfolio has been losing pace.
Chart 17. Annual change in the portfolio of MFI loans granted to NFCs and households
Source: Bank of Lithuania.
8.General government finance
In 2021, the general government deficit is projected to be 0.5 percentage point lower than in 2020, reaching 6.9% of GDP, according to the 2021 budget revised in June. The narrowing of the deficit has been facilitated first and foremost by the growing economic activity leading to a more rapid growth in revenue from major taxes and social contributions as well as to the above-target revenue collection. The improved performance has also been driven by the shift of tax arrears to a downward path. Tax arrears soared by more than €800 million last year due to a temporary tax deferral option offered to the businesses hit by the pandemic. Even though this option remained available until 31 August, the arrears have set on a declining trajectory, which implies its use by only some of the companies, while some of the businesses that deferred taxes last year have already started paying off their arrears. The reduction of the VAT rate for catering, cultural and sport sectors in the middle of the year will act as a temporary drag on tax revenue. The preferential rate should remain in effect until the end of 2022.
A year-on-year decrease in the scale of fiscal measures implemented in 2021 to mitigate the fallout from the pandemic and restrictions on economic activity have led to a slower growth of expenditure.
Chart 18. General government expenditure dynamics and its contributions
Sources: Statistics Lithuania and Bank of Lithuania calculations.
The ratio between general government debt and GDP will increase both this year and in the medium term. In accordance to the revised 2021 budget, the debt will be close to 50% of GDP this year and will increase in subsequent years, before stabilising at 52% of GDP. The growth in the debt ratio will be driven by the deficit planned throughout the medium term, although its effect will be subdued to some extent by the expected growth of nominal GDP and the average interest rate on government debt, which has decreased in recent years.
Chart A. Evolution of average retirement pension and poverty threshold in Lithuania
Sources: Statistics Lithuania and Bank of Lithuania calculations.
It should be pointed out that the rather rapid increase in the poverty threshold, which has been observed in recent years, has been driven by the rapid growth of wages recorded across all wage intervals. The automatic adjustment mechanism for the indexation of pensions in line with the multi-annual average growth rate of the wage bill was only rolled out in 2018, replacing the previous approach to pension increases, which was based on discretionary, or ad hoc, decisions of the Lithuanian government and was insufficient to make sure that the growth pace of the average pension at least matched the rate of increase in the at-risk-of-poverty threshold. Therefore, the gap between the average retirement pension and the poverty threshold, which remained positive between 2009 and 2014, slid back in the negative territory in 2015 and has been widening ever since.
Hence the country has found itself in a situation where the status quo – the average pension below the at-risk-of-poverty threshold for a single person – is unsatisfactory, but should not change substantially in the near future, based on the legislated indexation mechanism. This leads to a natural question: what should be done?
On 15 July 2021, the Ministry of Social Security and Labour of the Republic of Lithuania (SADM) put forward proposals for the reduction of poverty among older persons, which stipulated that, firstly, in the years when the State Social Insurance Fund Board (hereinafter – Sodra) is projected to run a budget surplus, 75% of that surplus, minus working capital, should be diverted to additional increases in the individual pension component. Secondly, it proposed to set the general component of the pension, paid to the persons having minimum-to-obligatory insurance record, equal to the full amount of the basic pension (instead of the share of the basic pension corresponding to the ratio between the person’s insurance record and the obligatory insurance record, according to the current practice).
In the opinion of the Bank of Lithuania, these proposals are insufficient to resolve the problem of small retirement pensions, as they only partly address the main causes of the existing situation. These causes are two: firstly, a relatively small share of revenue from pension social insurance contributions allocated for the payment of retirement pensions, and, secondly, the existing structure of the retirement pensions paid by Sodra, which does not help to aptly reduce poverty of small pension beneficiaries. This is due to the fact that the general pension component accounts for a relatively high proportion of the total amount of pension, in particular in cases of lower income (ranging from the minimum wage to the average wage). Efforts to make effective use of existing limited resources for lifting the income of the poorest retirement pension beneficiaries, for instance, by increasing the amount of the basic pension, will lead to an across-the-board rise in pensions of all pension beneficiaries, including those who receive larger pensions, due to a respective increase in the general component of their pensions. Hence, a substantial share of limited available resources will not achieve the intended purpose.
Chart B. Relation between social insurance contributions and social benefits for old age in EU countries in 2010–2019
Sources: Eurostat and Bank of Lithuania calculations.
Note: *Social benefits before taxes.
The analysis of the data on social contributions collected by EU countries and social benefits allocated to the elderly (before taxes) has shown that the proportion of revenue from contributions allocated for the payment of retirement pensions in Lithuania is relatively small (see Chart B). It should be noted that the gap between the social contributions-to-GDP ratio in Lithuania (11.6% on average in 2010–2020) and the respective ratio of euro area countries (15.3% on average in 2010–2020) is far narrower compared to the social benefits’ gap, as social benefits for old age in Lithuania accounted for 5.5% of GDP on average between 2010 and 2020, as opposed to the euro area’s average ratio of 10.1%. In order to bring the relation between social contributions and benefits in Lithuania in line with the trend among all EU countries, the ratio between social benefits for old age and GDP in Lithuania should be higher by approximately 2.5 percentage points. This would imply that, for instance, in 2020, total expenditure on retirement pensions should have reached €4 billion instead of €2.8 billion, and the average retirement pension should have been larger by approximately 40% (€575 instead of €400). In this case, the average pension would have exceeded the at-risk-of-poverty threshold for a single person substantially.
Chart C. Social insurance balance broken down by insurance scheme (12-month moving sums)
Sources: Sodra and Bank of Lithuania calculations.
Chart D. Comparison of structures of Sodra’s retirement pensions (existing structure (top panel), proposed by SADM (middle panel), proposed by the Bank of Lithuania (bottom panel))
Sources: Sodra and Bank of Lithuania calculations.
The forecasts of economic indicators made by various institutions, including the Bank of Lithuania, are released as point estimates, i.e. specific future values or growth rates, thus reflecting the most probable development of the selected indicators during the period under review. Still, the economy is affected by many different factors, their effect and interrelations are complex and diverse, and they may change due to various unforeseen circumstances, therefore, the results of economic processes and their interaction are usually not clearly known. Moreover, it is almost impossible to foresee certain phenomena (for example, geopolitical tensions, pandemic, etc.) and it is very difficult to forecast their precise impact on the economic developments. Therefore, even when the most progressive methods are applied, it is necessary to have in mind that deviations of economic forecasts are unavoidable in forecasting. In other words, it is always necessary to have in mind that the forecast of any economic indicator is always related to a certain amount of uncertainty.
Chart A. The latest real GDP growth rates and their estimates (top of the chart) and the differences in the latest real GDP growth rates and their respective estimates (gaps, bottom of the chart)
Sources: Statistics Lithuania and Bank of Lithuania calculations.
In addition to other factors, forecast deviations are also determined by statistical data reviews. For example, Statistics Lithuania publishes and updates the real GDP growth rate at least several times according to additional information received, and this is a usual practice in all EU Member States. It can be seen from Chart A that the differences between the first real GDP growth rate estimates and subsequent updated or final growth rates may be quite significant in some quarters, reaching 0.5 to 1 percentage point or more (see the bottom part of Chart A). In the period from Q1 2010 to Q2 2021, the average difference between the latest available updated data and the first, second and third estimate of the annual real GDP growth rate was positive and comprised almost 0.4 percentage point. This means that the first growth rate estimates were lower on average during this period, compared to the growth rates calculated according to the latest data. As forecasting real GDP growth rates uses several first GDP growth estimates (the first one, more rarely also the second one) for the last quarters, their reviews, in addition to other factors, determine the deviation of the GDP growth rate forecasts.
Chart В. Average absolute deviation in each quarter of the two years of the forecast
Sources: Eurostat, Statistics Lithuania and Bank of Lithuania calculations.
Chart C. Inflation (top), core inflation (middle) and real GDP (bottom) developments and forecasts
Sources: Statistics Lithuania and Bank of Lithuania calculations.
Owing to high volatility of energy and food prices, the highest uncertainty surrounds the gross inflation forecast. It can be seen from Chart C that the width of the range of 1 and 2 average absolute deviations for gross inflation is larger than the width of the range of deviations for real GDP and significantly larger than the range of deviations for net inflation. The fact that net inflation forecast deviations are significantly lower than those of gross inflation is not surprising, as the deviations of gross inflation forecasts is significantly increased by the deviations of forecasts for such difficult to project variables as energy and food prices. After the exclusion of these two product groups where prices are highly volatile, the average forecast deviation of other prices (or net inflation) is substantially lower and comprises around 0.5 percentage point, whereas net inflation forecast margins equal to one or two typical deviations comprise around 1 and around 2 percentage points respectively.
Abbreviations
CPI consumer price index
EC European Commission
ECB European Central Bank
EU European Union
EURIBOR Euro Interbank Offered Rate
Eurosystem European Central Bank and euro area national banks
Eurostat statistical office of the European Union
GDP gross domestic product
HICP harmonised index of consumer prices
IMF International Monetary Fund
MFI monetary financial institution
NFC non-financial corporation
PEPP pandemic emergency purchase programme
PMI purchasing managers' index
UK United Kingdom
USA United States of America
VAT value-added tax
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© Lietuvos bankas Gedimino pr. 6, LT-01103 Vilnius The Lithuanian Economic Review analyses the developments of the real sector, prices, public finance and credit in Lithuania, as well as the projected development of the domestic economy. The material presented in this review is the result of statistical data analysis, modelling and expert assessment. The review is prepared by the Bank of Lithuania. The cut-off date for the data used in the publication is 10 September 2021. Reproduction for educational and non-commercial purposes is permitted provided that the source is acknowledged. ISSN 2029-8471 (online) |